The Tezos affair: the "ICO fever" and its risks

This “ICO fever”, which involves colossal sums, is currently taking place outside of any regulation. The unprecedented nature of Blockchain technology and the virtual currencies of which it is the support means that they do not correspond, for the time being, to any given legal category and do not fall under any identified regulation. The gold rush of ICOs is therefore carried out without any control, to the delight of the most libertarians but at the cost of immense risk-taking. Happiness can thus quickly fly away if the windfall disappears, either because the technology has a flaw, as in the TheDAO affair ($ 50 million stolen from Ethereum in June 2016), or because a conflict breaks out between initiators of the fundraising, as in the current Tezos affair.

Last July, the Tezos ICO raised $ 232 million, one of the largest fundraisers ever through an ICO to date. Behind Tezos is a Franco-American couple formed by Kathleen and Arthur Breitman. Polytechnic, having studied financial mathematics at NYU, Arthur Breitman went through Goldman Sachs and Morgan Stanley. His wife, Kathleen, worked for a hedge funds and a company developing blockchain technology. Ideologically, the couple claims a radical libertarianism which sometimes qualifies itself as “anarcho-capitalism”. Since last May, the Breitmans have been joined by a famous venture capitalist from Silicon Valley, Tim Draper, who believes in their project and has invested in their American company and in the ICO carried out in July.

The Tezos project

In 2014, Arthur Breitman, who has followed the evolution of Bitcoin since its creation in 2009, designed a new type of blockchain, called Tezos, with more secure and satisfactory governance than that implemented in the Bitcoin blockchain. He has the idea of ​​offering, as Ethereum does, a decentralized network that can support smart contracts but by means of more secure and sophisticated technology (v. position paper published by A. Breitman under the name LM Goodman, " Tezos: A Self Amending Crypto-Ledger Position Paper ", August 2014, which highlights this quote from Proudhon:"Leave it to the owners », A principle widely implemented by Tezos).

The Tezos blockchain does not resume the cryptographic processing allowing the validation of transaction blocks used by the Bitcoin network. The Bitcoin system is based on the " proof-of-work »(Proof of work): the people who use the computing power to validate transaction blocks (the miners) are put in competition for the validation of each block. The validation of the block is carried out when the miner finds the result of a "hash" function corresponding to the block. It is the miners who provide the computing power and the energy. This validation system is slow and costs Bitcoin users around 400 million euros per year (for more explanation on these questions, see Blockchain France, Blockchain decrypted, and in particular the lexicon at the end of the book).

Tezos uses a different technique to achieve distributed consensus. On the Bitcoin network, the interests of "miners", " are subtly different from the interests of the holders "Bitcoins, underlines the position paper from 2014. Gold "Miners could hold Bitcoin hostage and force its participants to increase the rate of inflation." The Tezos Blockchain thus favors the proof-of-stake, which is less expensive and gives clearer guarantees of consensus. The proof of stake does not require users to use their computing power but rather to prove ownership of a certain amount of cryptocurrency.

In addition, the programming language developed by Tezos, called Michelson (note: Michelson, Nobel Prize winner in physics in 1907 had built an "interferometer" to demonstrate the existence of the ether), allows you to program "smart contracts" (smart contracts). This language is different from the programming languages ​​used until now, and in particular from the EVM (Ethereum Virtual Machine) less suited, according to Breitman, to smart contracts. The Michelson was created in order to lend itself to a formal verification, which allows to rigorously prove that a program behaves as expected which, according to its designer, would prevent bugs and flaws, such as error programming that allowed the theft of funds invested in TheDAO in June 2016.

Above all, Breitman conceives the Tezos project with a very successful philosophy in terms of governance, which he details in an interview with Counterpoint in November 2016. " The invention of the blockchain, exhibits Breitman, enabled the deployment of decentralized ledgers, ie a shared accounting mechanism, accessible to all, and not under the explicit control of anyone ”. However, this is precisely what makes the “revolutionary” character of the Blockchain. Where the Internet has allowed almost universal access to information, blockchains provide access to consensus coordination, which can not only take the form of a virtual currency (Bitcoin, Ethereum) deriving its value from a consensus around its usefulness but also of settlement & delivery compensation mechanisms, various registers, cryptographic identities etc ... It is now possible, says Breitman, to use the Blockchain to conclude, between people very distant geographically, of contracts verified, validated and executed at a minimum price, without any recourse to a trusted third party, whatever it may be.

However, for Arthur Breitman, this revolutionary advance is not accompanied by appropriate solutions from the point of view of governance. Governance, defined as " a set of rules by which a group of people share a resource ”, is what makes it possible to pronounce on the administration and the evolution of the network. On existing networks (Bitcoin and Ethereum), he says, this governance is far from ideal. “A myth persists around Bitcoin, the idea that the network is purely 'mathematical', ideal, platonic, immutable. In fact, although many aspects of the protocol are purely mathematical, its proper functioning depends on conjecture about the behavior of the actors who validate and use its blockchain ”. These problems are even more pronounced for Ethereum, led by a foundation with a broad influence on the technological evolution of the network and its governance.

Tezos' project is therefore to offer a more satisfactory blockchain in terms of governance, which uses " the consensus capacity of the blockchains themselves to implement their own governance models ". In the Tezos Blockchain, holders of Tokens can accept or reject protocol updates (ie the rules followed by the network) through a majority voting system. Update submissions may contain terms that compensate their creators, creating an incentive to maintain and improve Tezos. The governance model itself is subject to updates and may gradually shift from this simple majority voting model to " a more sophisticated model including safeguards or introducing checks and balances ».

 Tezos' governance mechanisms are inspired by the work of several authors to whom Arthur Breitman expressly refers (Elinor Ostrom, Robin Hanson, Murray Rothbard, Friedrich Hayek). His main reference is Peter Suber, the American philosopher who created the game Name. Nomic is a game " which consists of starting from a set of minimum rules - but allowing self-amendment - to build a system of Byzantine rules making it possible to trap other players ". The game illustrates the " self-amendment paradox According to which it is possible for a system of rules to provide for its own replacement (see Peter Suber, The Paradox of Self-Amendment: A Study of Law, Logic, Omnipotence, and Change, http://legacy.earlham.edu/~peters/writing/psa/index.htm). The objective of Tezos is not, however, specifies Breitman, to lead to the replacement of the system: it is necessary " determine initial rules sufficiently liberal to allow the system to evolve, but sufficiently conservative to create a virtuous circle of governance and innovation ”. On the Tezos blockchain, only holders of Tokens may accept or reject protocol updates by majority, at least initially: subsequently, the modalities for adopting or rejecting updates may change (https://www.wired.com/2017/03/plan-save-blockchain-democracy-bitcoins-civil-war). 

The Tezos company and the ICO 

In 2015, Arthur Breitman creates and registers, in the State of Delaware, the company Dynamic Ledger Solutions Inc. (DLS) which must develop Tezos and of which he is the President. The company only develops software. It is expected that she will partner with a nonprofit foundation that will launch the network in the form of a crowdsale similar to the one conducted by Ethereum in 2014. The idea is that users can acquire Tezos tokens allowing them to use the services provided by Tezos. The foundation, then said Breitman, " will have the role of helping the networks to take their first steps during the first years, but will not replace the governance model ».

In 2016, a first fundraising allowed Tezos to receive $ 612,000 and to prepare an ICO. A non-profit foundation based in Switzerland, in the canton of Zug, was then created, responsible for leading the ICO. Zug (https://www.letemps.ch/economie/2017/08/11/zoug-ruee-vers-lor-xxi-siecle) otherwise called the "crypto-valley" hosts many startups working on virtual currencies and blockchain, especially since the Ethereum network, managed by a Canadian foundation, carried out its first fundraising there in 2014. The city of Zug today offers a digital identity to its inhabitants (on the development of Blockchain in Switzerland, see: https://www2.deloitte.com/ch/fr/pages/innovation/articles/the-blockchain-revolution.html).

Arthur Breitman's plan is that the foundation, a legal entity under Swiss law, buys DLS after raising funds from the ICO, then develops the Tezos technology under open source. It is expected that after three months of satisfactory operation of the Tezos network, the shareholders of DLS (the Breitman and Draper) will receive an amount in cash equivalent to 8.5% of the funds raised under the ICO, then, within 4 years following, 10% of "Tezzies" (Tezos tokens) issued gradually (https://www.reuters.com/article/us-bitcoin-funding-tezos-specialreport/special-report-backroom-battle-imperils-230-million-cryptocurrency-venture-idUSKBN1CN35K). The management of the foundation is entrusted to a board 3 trustees which is chaired by a South African entrepreneur based in Zug, Johann Gevers. The Breitmans have no function there: the foundation and its board are completely independent, in accordance with Swiss law. The role of the foundation and its board is to control the use of funds, so that they are used in the development of the Tezos project.

The idea of ​​having the ICO carried out by a legal person governed by Swiss law is not new and is widely favored by startups for several years. It leads the Tezos ICO to come under Swiss law, even if the plan is to see the foundation buy DLS at a later date. Swiss regulations are not very restrictive and there are no provisions relating to ICOs any more than elsewhere. If it appeared that the ICO consists of issuing financial securities, then Swiss law would oblige the issuer to obtain authorization from the financial authorities. The fact remains that the legal nature of Tokens created on the different blockchains is uncertain. Regarding Tezos, the terms of the ICO are precisely planned so as to avoid any qualification as a financial security. Indeed, the investment in the Tezos ICO is presented as a “non-returnable donation” which cannot constitute a speculative investment. Financial regulation is therefore not applicable here.

Driven by the good reputation of Tezos technology, which can, it is said, support a large number of applications, the ICO, which takes place in Switzerland between 1^er and on July 13, 2017, was a great success. The approximately 66,000 Bitcoins and 361,000 Ethers raised represent around $ 232 million at the time of the ICO, but do much more today (around $ 400 million) given the very significant rise in Bitcoin and Ether since. The importance of the amounts collected was also made possible by the absence of an investment ceiling, even if the Breitmans communicated the amount they deemed necessary (in this case $ 20 million).

The dispute

The operation very quickly degenerates into conflict between Arthur and Kathleen Breitman, on the one hand, and Johann Gevers, the president of the Swiss foundation, on the other. Collaboration with the foundation has become almost impossible, say the Breitmans ( http://fortune.com/2017/10/19/tezos-ico/). Johann Gevers would have, by his attitude, hindered the progress of the Tezos project and tried, by putting pressure on the other members of the board, to grant yourself a very important bonus without revealing its real amount to them. For his part, Gevers claims the independence of the foundation, which currently holds all of the funds raised, and complains of the interference of the Breitmans, to whom he blames the delay in the development of the network. Gevers, who was suspended for one month from his operational duties by the board, announced that it had initiated legal proceedings before the Swiss courts.

For the time being, the foundation holds the tokens (Bitcoins and Ethers) invested in the ICO, which it gradually exchanges for Swiss francs, while the Breitmans hold the intellectual property rights on the technology. The launch of the Tezos network is now delayed, which has the effect of also delaying the distribution of the Tezos cryptocurrency, which consists of Tezzies.  As long as this launch does not take place, investors receive nothing…. but they had, moreover, no guarantee of receiving anything under the very terms of ICO's offer (which specified that the project could be abandoned). Certainly, some exchanges take place between private persons or on IOU markets. The fact remains that the value of "Tezzies" on the futures market has fallen significantly due to the delay in the project.

The Breitmans' difficulties are not limited to this violent conflict with the President of the Swiss foundation. In the United States, two law firms (one in Boston, the other in San Diego) announced that they had initiated investigations in order to trigger a class action (class action) for the benefit of investors in the ICO for breach of financial regulations. The objective would be to obtain the return of the funds raised during the ICO. The legal reason put forward is that the Breitmans, their company DLS and the Swiss foundation have violated US law. However, American financial regulations are only applicable if we can qualify the Tezzies of financial securities (securities): If this is the case, then these securities should have given rise to registration with the SEC once investors based in the United States have subscribed to them. And in the absence of SEC registration, funds raised should be returned. However, it is difficult, at this stage, to determine whether the initiators of these actions will succeed in establishing both the qualification of security and proof that the investors are located in the United States.

Should the Tezos affair lead to the conclusion that ICOs are, decidedly, too risky operations to be authorized and to approve the countries which, like China or South Korea, have banned them? The most reasonable would undoubtedly be that the various States adopt measured regulations making it possible to secure fundraising and protect investors without restricting all freedom and all innovation. If an ICO leads to the issuance of Tokens that can be qualified as financial securities, then it is relevant to apply financial regulations to it, as indicated by a certain number of regulators (in the United States, Canada, Singapore, Australia, etc.). The Swiss authorities themselves, however very flexible, have recognized that some ICOs may fall under financial regulation (http://www.businessinsider.fr/us/switzerland-ico-crackdown-2017-9/). As for the ICOs for which the qualification of security can be contested, as is the case with Tezos, it would no doubt be advisable to adopt a few simple rules in order to ensure legal certainty for investors and beneficiaries alike. This is what a number of representatives of the French ecosystem called for in a recent column published on Medium (https://medium.com/@AlexStach/ico-limp%C3%A9ratif-de-la-transparence-603a41920741). The French Financial Markets Authority (AMF) should take a position quickly (https://www.afp.com/fr/infos/330/les-levees-de-fonds-en-monnaie-virtuelle-au-coeur-dun-debat-existentiel). She has already, in her 2017 risk mapping, devoted a few pages to the blockchain in which she assimilates the platform The DAO to a "fund whose shares are denominated in cryptocurrency". It has also just launched a consultation on the question (( http://www.amf-france.org/Actualites/Communiques-de-presse/AMF/annee-2017?docId=workspace://SpacesStore/5097c770-e3f7-40bb-81ce-db2c95e7bdae), based on the finding that “ a large part of the ICOs observed could be covered by existing legal provisions (regulations applicable to intermediaries in various goods, to the public offering of financial securities or to alternative investment fund managers, in particular) While others remain, in the current state of the law, outside any regulation.

It remains to be hoped that the Tezos project, based on sophisticated technology and carrying an original approach to governance, will not be swept away by the current crisis.